Fizzled Goldman Sachs Cases Put S.E.C. in Harsh Light

Fabrice Tourre, a former Goldman Sachs trader, became both a symbol and a scapegoat of the 2008 financial crisis.CreditCreditRichard Drew/Associated Press

By Peter J. Henning

May 2, 2016

The Securities and Exchange Commission is supposed to be Wall Street’s top cop, charged with protecting investors while it ensures that brokers and bankers adhere to the rules.

Recent articles in The New Yorker and Fortune, however, raise questions about whether the agency was willing to take on tough cases against one Wall Street firm, Goldman Sachs, and its executives. They feed into a broader concern about whether the agency can adequately police the markets by taking on the biggest players.

Jesse Eisinger of ProPublica, who has contributed to DealBook and has delved deeply into the financial crisis, wrote the article in The New Yorker about the S.E.C.’s decision not to pursue charges against any senior executives at Goldman related to a synthetic collateralized debt obligation put together by the firm. Fabrice Tourre, a midlevel trader who helped structure the transaction, was the only individual accused of wrongdoing.

A lawyer at the S.E.C. assigned to the case provided materials showing that the agency seemed to avoid pursuing more senior executives for their role in the deal, at least not until the last moment. A supervisor at the agency stated in an email that many involved in the transaction were “good people who had done one bad thing,” and later wrote about the financial crisis “that the vast majority of the losses suffered had nothing to do with fraud and the like and are more fairly attributable to lesser human failings of greed, arrogance and stupidity of which we are all guilty from time to time.”

When the time came to finally decide who to sue, those involved in the investigation were split about suing anyone at Goldman above Mr. Tourre. In the end, Robert S. Khuzami, the enforcement director at the time, said that “the lack of consensus among our group is itself, for me, confirmation” that others should not be named.

Goldman settled the case three months after being sued by paying a $550 million penalty and admitting that the marketing materials for the C.D.O. “contained incomplete information.” But the S.E.C. dropped the most serious fraud charge against the firm, resolving it under a provision that only requires negligence rather than an intent to defraud. Mr. Tourre was found liable by a jury in 2013.

Stephen Gandel wrote in Fortune about a mortgage-backed security assembled and sold by Goldman that bundled more than 5,000 residential subprime mortgages, eventually costing investors more than $500 million when many of the shoddy mortgages went into default. Although the S.E.C. notified the firm in February 2012 that it planned to pursue civil fraud charges, no further action was taken. In an August 2012 filing, Goldman disclosed that the case had been dropped, but no reason was ever provided by the agency for its decision.

The Justice Department later reached a $5 billion settlement with Goldman for its sale of residential mortgage-backed securities from 2005 to 2007, including the security the S.E.C. investigated in 2012 but decided not to act on.

According to Mr. Gandel, the chairwoman of the S.E.C. at the time, Mary L. Schapiro, said that the case against Goldman never reached the five commissioners to review and decide whether to proceed with civil fraud charges. That means the decision to drop the matter was made by the staff in the enforcement division, even though there was enough evidence at one point to send a so-called Wells notice telling the firm that it planned to recommend charges.

After the debacle in 2008 over the S.E.C.’s failure to do anything about the huge Ponzi scheme perpetrated by Bernard L. Madoff that resulted in investors losing billions of dollars, there was a promise that the agency would take a tougher approach. In many ways, the enforcement division patterned itself after the Justice Department, with former prosecutors, like Mr. Khuzami, assuming leadership positions.

Mary Jo White, the current chairwoman of the S.E.C., spoke in 2013 about adopting the “broken windows” approach used with great success by the police in New York to send a message to Wall Street that the agency was going to take a harder line on small violations. It followed the lead of federal prosecutors in offering leniency to those who cooperated, while announcing that in some cases it would require an admission of a violation rather than the usual approach of neither admitting nor denying the charges.

But The New Yorker and Fortune articles raise the question whether the S.E.C. was willing to take on the tough cases against a well-funded opponent like Goldman, at least when the evidence of wrongdoing was not overwhelming. The agency continues to highlight its pursuit of insider trading cases, but those have minimal impact on the markets compared with pursuing wrongdoing inside a large organization.

Prosecutors and administrative agencies have the widest discretion when deciding not to accuse someone of violating the law. That decision is almost always made in secret, with no outside review. It involves weighing the evidence to determine not only whether charges could be brought, but more important whether the case has a reasonable chance of success because merely filing an accusation can have a devastating impact on the defendants.

Being in law enforcement means making tough calls, and running the risk that a case will be lost. In the two cases involving Goldman and its executives, there was no “right” or “wrong” decision to be made because the evidence of violations was equivocal, so choosing not to proceed is certainly defensible.

The broader issue to consider is the message sent when the choice is made not to pursue a case, even though charges could have been filed. Goldman publicly disclosed that it had been notified by the S.E.C. of possible charges in 2012 related to the mortgage-backed security it sold, and then the case quietly disappeared. That does not inspire public confidence, especially when that deal, along with others, turns up four years later as part of a $5 billion settlement with the Justice Department.

The lesson for the financial industry may well be to fight the case, or at least not try to settle it too quickly, when the evidence of wrongdoing is ambiguous.

For the public, the S.E.C.’s decision not to pursue charges feeds the continuing mistrust that the agency will not take on difficult cases if it can get a quick settlement instead, even one without an admission of wrongdoing. Whether that perception fair, it is certainly prevalent.

The articles by Mr. Eisinger and Mr. Gandel show that these were close calls, certainly not slam-dunk cases. Without an explanation about why the agency’s staff reversed its course in one instance and choose not to pursue individuals in senior management in the other, we are left to speculate about the reasons.

The cases have been put to rest and cannot be revisited now. The S.E.C. does not have to explain why it chooses to drop a case or pass on charging potential defendants, but then it cannot object when the public draws its own inferences from a failure to act.